Navigating the Unexpected with Gold
2020 has brought dramatic change to asset markets around the globe. As equity and bond markets upended in early 2020, gold shined — playing an important and timely role for many investors as a potentially valuable source of diversification, risk-adjusted returns and deep liquidity that may help mitigate portfolio drawdowns in portfolios. These historic benefits of gold during times of market turbulence have helped earn it a reputation as a potential safe-haven asset.1
An Asset for Managing Rising Volatility
Gold may provide unique diversification to portfolios as an asset that has historically maintained a low or sometimes negative correlation to many other traditional asset classes, such as stocks and bonds. And in an environment filled with macro-induced volatility — such as we see today — gold has, on average, outperformed many other alternative assets or commodities often used by investors to navigate market turbulence.2 Gold’s performance during 2020’s market turbulence helps illustrate the role that gold can potentially play in a portfolio to help navigate rising market volatility and risks.
Source: Bloomberg Finance L.P., and State Street Global Advisors, as of August 31, 2020. Gold is represented by LBMA Gold Price PM (USD/oz).
*August 15, 1971 – President Nixon removed gold/US dollar from Bretton Woods system and the price of gold was then determined by open market forces, rather than by being linked to the US dollar. **Bloomberg Barclays US Agg TR Index was launched on January 30, 1976. Past performance is not a guarantee of future results. Performance above does not reflect charges and expenses associated with the fund or brokerage commissions associated with buying and selling exchange traded funds. Performance above is not meant to represent the performance of any investment product.
With a relatively deep and liquid trading market — even during extreme market volatility — gold averages a daily turnover of $188 billion, a volume on par with the S&P 500 Index of $212 billion.3 Our gold investor conversations have revealed — and history shows — that during volatile markets, investors have often relied on their gold holdings for liquidity purposes — or cash — to meet margin calls or avoid selling other securities that are declining. This dynamic can manifest itself in the gold price initially declining along with equities, but then recovering to go on to find higher ground once liquidity demands abate.
More on Gold
Source: Bloomberg Finance L.P. and State Street Global Advisors, date as of August 31, 2020.
For insights on gold’s liquidity and how it performed during the 2020 COVID-related market volatility, read our Gold Midyear Outlook.
Understanding Gold Today
Gold is not just a tactical asset for times of crisis. Despite gold’s strong 2020 performance, investors often misunderstand the unique and diverse potential benefits of investing in gold on a more strategic and longer-term basis.
Recently, we’ve been asked by clients:
Is gold only useful as a short-term tactical solution during market downturns?
In addition to its potential “safe-haven” appeal during critical market downturns, gold can also play a much longer-term and strategic role for investors — potentially providing portfolios a multifaceted, robust hedge against varying types of unexpected risks and market events.
Gold’s unique risk/reward characteristics, coupled with its diverse sources of demand, enable it to potentially help limit drawdowns and preserve wealth over the long run, across varied business cycles.
And as a tangible asset that has been used since ancient times as a medium of exchange or symbol of wealth, gold holds up as a historical store of value without the counterparty risk of stocks and bonds. Since August 15, 1971, when the gold price was first determined by open market demand, gold has provided a compound annual growth rate of 8.11%.4
Source: Bloomberg Finance L.P., and State Street Global Advisors, date range from December 31, 1970 to August 31, 2020. Past performance is not a guarantee of future results. Performance above does not reflect charges and expenses associated with the fund or brokerage commissions associated with buying and selling exchange traded funds. Performance above is not meant to represent the performance of any investment product.
Is Gold Too Risky to Include in Portfolios?
Today’s combination of volatility and lower returns from traditional asset classes means that interest in gold has increased. And as investors are faced with understanding the risk/reward profile of many different assets under a new risk regime, volatility is one measure that can help investors set meaningful guardrails and construct portfolios within their investment objectives. But many investors may mistakenly view gold’s periodic and short-term price changes as a proxy for the asset’s overall volatility. Although the gold price has sometimes exhibited significant movement on a short-term basis, it’s really been a different story longer term.
In fact, gold’s rolling 3-year annualized volatility over the past 30 years is 11.42% – slightly lower but generally on par with the S&P 500, which posted an 11.80% rolling 3-year annualized volatility over the same period.5 As illustrated below, both gold and the S&P 500 Index’s rolling 3-year standard deviation of weekly returns has generally remained close – other than in the late 1970s and early 1980s, when US inflation was high and the Fed was forced to raise the federal fund rate (upper bound) to 20%.6
Further, if one considers that indices tend to be less volatile than their individual components, gold’s potential volatility may be less of a concern when compared with individual stocks, sectors or other securities.
Source: Bloomberg Finance L.P., State Street Global Advisors, data from August 20, 1974 to August 31,2020. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Past performance is not a guarantee of future results.
For investors more familiar with real asset exposures in their portfolio construction strategy, gold has historically provided lower volatility relative to many other precious metals, commodities and real estate.
Source: Bloomberg Finance L.P., State Street Global Advisors, data from August 31, 2012 to August 31, 2020, reflect annualized monthly averages for 120 months. Past performance is not a guarantee of future results.
Although gold is unique from many other assets, including how its price has historically moved — which has often been represented by short-term rises and pullbacks that generally operate within a technical support/resistance zone — its overall, longer-term price volatility has tracked near — or below — many other assets, as illustrated above.
If gold doesn’t pay income or dividends, it isn’t as good as bonds, right?
Gold does not pay a coupon or dividend like most stocks and bonds. Instead, gold’s value is rooted exclusively in its price appreciation. But, an investment in gold does not carry the counterparty risk of many bonds, where payments are contingent on the creditworthiness of the underlying bond issuer — many of which have gotten stretched and downgraded in 2020, according to S&P Global Ratings. In fact, during Q2 2020, S&P Global Ratings reported lowering 414 long-term issuer credit ratings, surpassing the prior peak of 331, which was set during 2008–2009 financial crisis in the first quarter of 2009.7
Source: Bloomberg Finance L.P., and State Street Global Advisors, as of August 31, 2020.
And with the high amount of global negative-yielding debt and the risk/reward profile of many bonds becoming less attractive in 2020, the opportunity cost of gold has declined further – meaning that gold may have the potential to outshine some bond strategies – despite not paying dividends.
Ultimately, gold may play a valuable role in investor portfolios during times of crisis and market downturns. But gold is far more than just a “crisis asset” — it may provide a diverse range of benefits that can potentially bring advantages to portfolios during positive markets too.
Today’s uncertain market environment may be an ideal time for investors to rethink many of their perceptions about gold – it’s also a good time for them to consider the strategic and tactical advantages an allocation to gold may potentially bring to investment portfolios in today’s more volatile market landscape.